This article was written for those who perform valuations for financial reporting purposes or review valuations completed by others for this purpose.
Earlier this year the International Valuation Standards Council (IVSC) released A Guide to the Audit Process for Professional Valuers, which helps to demystify the sometimes arcane world of the accountant.
The IVSC guide describes the financial reporting environment, the various roles of the independent auditor and of the professional valuer, and how these two professions need to interact and cooperate in order to achieve what is required by financial reporting standards. It has taken some three years to develop, and has involved widespread consultation with professional organisations, valuation providers, writers of financial statements, and auditors.
Valuations can have a significant impact on a company’s financial performance, but in recent years there has been increasing concern among regulators, not only because of the quality of the valuation estimates provided by management, but also the degree of scrutiny to which those estimates are subjected during the audit process. A recent survey of audit regulators in more than forty countries revealed that problems with valuation measurements came top of the list of topics that had caused adverse reports on the audit of listed companies.
The IVSC guide is aimed at raising awareness among professional valuers of audit procedures, to help ensure that the service they provide enables a company’s management to include high quality valuation estimates in their financial statements, and an auditor to more easily assess those estimates.
Without clear lines of communication, transparency and cooperation between valuers and auditors, it is very difficult to achieve these outcomes. The guide is intended to help raise awareness of the matters that an auditor is required to consider in respect of valuations intended for use in financial statements. By ensuring that the initial valuation is fit for purpose and that there is a proper dialogue between all parties involved, many of the problems that have emerged can be resolved.
The increasing use of a fair value based framework within both International Financial Reporting Standards provides two situations where valuers can assist the accounting and auditing profession. The first circumstance is by assisting in the reporting of entity management, in estimating the fair value of the reporting entity’s assets for their financial reporting requirements. The second circumstance arises if the reporting entity’s auditor requests the assistance of a valuation professional in auditing the fair value estimate.
Many readers may be surprised by the phrasing adopted. While valuers provide valuations and valuation advice, it is the reporting entity’s management that is ultimately responsible for estimating the fair value of the reporting entity’s assets. From a practical perspective, in most cases where management have obtained independent third party valuations from a professional valuer, it will invariably adopt those valuations without any adjustment; however, that is a matter for management to determine. Where management has relied on the advice of an independent valuer, the auditor will need to make a judgement as to the quality and reasonableness of those valuations.
Probably one of the most misunderstood role is that of the independent auditor, whose duty is to express an opinion on whether the financial statements of a reporting entity have been prepared in accordance with the applicable standards and present a true and fair view of the entity’s financial position and performance.
This is achieved through obtaining reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error. It is important that the auditor be independent of the reporting entity being audited. Users of the reporting entity’s financial information, such as investors, government agencies, and the general public rely on an independent auditor to present an unbiased audit report.
Most auditors are required to follow auditing standards. The IVSC guide focuses on the International Standards on Auditing (ISAs) issued by the The International Auditing and Assurance Standards Board (IAASB) and published by the International Federation of Accountants (IFAC), which are widely used.
In Australia, we rely on the Australian Auditing Standards (AAS), which are based on ISAs but modified for the Australian environment. A company complying with AAS would be in compliance with ISAs; however, a company complying with ISAs may not be in compliance with AASs.
While many valuation professionals will generally be familiar with financial reporting requirements through past engagements, this appreciation becomes especially important with the revised ISA 620: Using the Work of an Auditor’s Expert, issued in March 2009 and now in effect for many audit engagements around the world.
Effective interaction requires mutual understanding of the respective responsibilities of each professional involved in the audit process. For the valuer engaged to either act for the reporting entity or by the auditor, there needs to be an appreciation of:
- the types of information that the auditor might request or discuss with the professional valuer,
- the factors that significantly affect whether the valuer’s work will be adequate for the auditor’s purposes, and
- the evaluations that the auditor is required to make based on the valuer’s work.
I imagine that the majority of API member experience in the financial reporting arena will be in the provision of valuations, to assist a reporting entity’s management in estimating the fair value of that reporting entity’s assets. Regardless of whether the valuer is engaged by the reporting entity or by the auditor, the valuation advice provided should be in accordance with recognised valuation standards. As a professional valuer operating in an accounting firm, I have firsthand experience of both circumstances.
I know that when I am acting in the latter role (as the auditor’s expert), many valuers are surprised by the level of scrutiny required to support their valuations. Suffice to say that “trust me, I’m the valuer” won’t cut it anymore!
One of the most consistent problems is a lack of sufficient disclosures in valuation reports. All significant assumptions that the valuer has made in reaching their valuation should be included in the report. If something has a material impact on value, the valuer should include sufficient information in the report for an independent third party to be able to understand how they addressed that aspect in the valuation.
Lack of sufficient disclosures will almost certainly result in the valuer receiving questions from the auditor’s valuation expert so that they can understand how the valuation has been done and whether the methods and assumptions adopted are reasonable. Full and transparent disclosures in the valuation report will provide greater comfort to the auditor that the valuation has been completed robustly and independently, and will ultimately save the valuer time and effort in explaining what they have done after the event.
We only have to look to the United States to see that the level of disclosures and information required by the auditor will continue to increase. The level of scrutiny in the US is another step higher than we have experienced thus far in Australia, and can include the auditor’s expert assessing whether information (e.g. comparable sales) relied on by the valuer is appropriate and reasonable, completing math checks, detailed reviews of inputs and assumptions, etc.
Auditors use the services of professional valuers, either within their own firms or external experts, to complete these reviews. The auditor is therefore relying on someone who understands valuations and knows how valuations should be completed. This means that they can quickly identify weak spots in a valuation analysis and know the tough questions that need to be asked.
And while the auditor’s expert will have regard to the professional valuer’s experience and qualifications, it is not sufficient for an experienced valuer to stand on their reputation and expect to avoid scrutiny.
If you are interested in learning more, I strongly encourage you to log on to IVSonline, which can be accessed online via the API’s or PINZ’s e-learning site. API members must register for access . By visiting IVSonline, you can access a wide range of IVSC materials including the publication that is the guide to the auditing process, as well as the International Valuation Standards and Technical Information Papers. The API and PINZ have made this service available to members free of charge, however registration is required to log in.
Given that the API and PINZ have both adopted the IVS as their over-arching standards, all members should be familiar with them. IVSonline is a searchable site and simple to use, and accessing the materials online also ensures that you are looking at the most current version of each publication.
Roy Farthing, FAPI, CPV (Plant & Machinery) is a partner with Ernst & Young in Melbourne where he leads the capital equipment valuation team. Farthing is the immediate past chair and current serving member of the Australian Valuation Standards Board and the current vice chair of the IVSC Professional Board.